Beware (the Stories) of the Death Cross

On Friday the S&P 500 experienced what is known as a “death cross.” This is when the 50-day moving average crosses below the 200-day moving average and as you can guess by the name, is allegedly a negative signal for stocks moving forward.

A lot of work has been done to debunk the myth of the death cross and yet we continue to hear about it whether it’s in an index, a sector or a specific stock. Here are two reasons why it refuses to go away: 1) It sounds ominous, people love that and 2) over the last fifty years, a death cross occurred before each of the ten worst years. Not only did they appear but in eight of those ten years the indicator was quite timely, saving those who listened from further downside.

So if it identified the very worst years, wouldn’t it be foolish to dismiss this as a valid indicator?

The problem with taking this too seriously is there were plenty of times this signal was indicative of absolutely nothing. Following a death cross stocks were lower by at least 10 percent twelve months later just ~27% of the time. The thing mainstream media never mentions is that a death cross tells you more about what has happened recently and little about what will happen going forward. In the table below, I looked at all 26 instances over the last fifty years.

To me, what stands out is how stocks performed in the month prior to the death cross. In 16 of the 26 occurrences (61% of the time) stocks were lower one month before. Looking out a year, returns following a death cross were indistinguishable from a randomly selected 12 month period. The median 12-month S&P 500 return (price only) is 10%. There were a few outliers that drags down the average to just 4%. What the data reveals, being overly simple is that most of the time stocks were fine except sometimes they weren’t.

I want to mention that I don’t know a single practitioner of technical analysis that incorporates the death cross into their work. You don’t need to see one moving average cross below another to tell you how stocks are behaving, price will do that just fine.

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